Investment Newsletter September 2018
America first When Donald Trump was elected as president he promised to put “America first�.
Mike Deverell Investment Manager
Equilibrium Investment Management
There is certainly one aspect where America is leading the way this year, and that is in the stockmarket.
All World Index ex-US, the green line) in dollar terms. The two lines tracked each other fairly closely until May. From then on, there has been a sharp divergence with the US continuing to rise whilst the rest of the world has fallen by nearly 6%.
Most markets around the world are flat at best so far in 2018. For example, the FTSE 100 started the year at 7,687 and as of close on 7 September it was at 7,277, down 5.3% in price terms (a 2.1% loss when you factor in dividends).
Whilst there are always differences in returns between different market regions, most major markets generally go up and down at the same time. It is very rare that you get such a sharp difference in direction.
Meanwhile, the S&P 500 (the main US market index) is up 8.4% so far this year in dollar terms (to 7 September). For a sterling investor, the gain is actually 13.3% as the dollar has also gone up by almost 5% against the pound.
One reason for this divergence has been Trump’s trade policies with the rest of the world. The first big round of trade tariffs imposed by the US on Chinese goods were announced in late May, around the same time that the US stockmarket and the rest of the world began to diverge. This timing is probably not coincidental.
Chart one, shows the US market (the red line) versus the rest of the world this year (represented by the FTSE
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter September 2018
Tariffs on trade may eventually hurt US companies too, with Apple recently warning that some of its goods will now be more expensive as a result. However, the impact has undoubtedly been greater on companies outside of the US in the short term.
There are several other reasons why the US has done so well in the past few months whilst other markets have slumped.
Chart 1:
A - S&P 500 (8.42%) B - FTSE all world ex US (-5.97%)
29/12/2017 - 07/09/2018. Data from FE 2018
Tax reforms
Firstly, Donald Trump’s tax reforms have had a big impact. Whilst earnings growth for companies around the world has remained relatively steady this year, in the US profits have risen quite sharply. The reduced tax burden paid by US companies has had a larger impact on the bottom line than many analysts had realised.
The much quicker pace of earnings growth in the US has been one of the key drivers of the outperformance of US shares. However, it must be noted that this is a one off move and does not mean the same level of growth will be repeated.
Strong dollar
A secondary effect of the tax reforms is that US companies have been “repatriating” their overseas holdings in very large numbers. This means there is a high demand for US dollars.
emerging market countries and companies have debts denominated in dollars. As the dollar rises, so does their level of debt and repayments in local currency terms.
At the same time, the US Federal Reserve is draining dollars out of the US financial system through the reversal of its quantitative easing programme. Essentially, this means there are less dollars to go around.
This has led to a sharp depreciation of many emerging market currencies. Several of those countries have been forced to increase interest rates, potentially harming their economies.
When there is an increase in demand and a decrease in supply, then prices have to rise. Trade tariffs have also contributed to what has been a very strong dollar so far this year. That is why a sterling investor would have made 13.3% from an investment in the S&P 500 even though the market is up only 8.4%.
Trump’s set of trade and tax policies has certainly put “America first” in the short term, but this has been achieved as much by the way they harm economies outside of the US as they have helped American companies and workers. Longer term, the strong dollar and tariffs on trade could end up harming the US economy too.
As the world’s reserve currency, a strong dollar can have wide ranging impacts. In particular, many Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter September 2018
Valuation
Volatility = opportunity
If you’d asked us at the beginning of 2018, we would have said most stockmarkets looked pretty expensive. Investments can fall as well as rise and – true to form – after poor performance this year coupled with steady earnings growth, many markets now look quite reasonable value. The exception, of course, is the US.
We therefore continue to hold less US equity than we normally would but are generally more optimistic about other equity regions. Having said that, should the US market dip back other markets would not remain immune and could potentially be dragged down with it.
Most major stockmarkets currently trade on a price to earnings ratio of between 13 to 15 times the underlying earnings of the companies, roughly in line with long term averages. By contrast, the US market expensively trades on over 23 times company earnings, well above long term trends. Even if we believed that earnings growth will be faster in the US than the rest of the world, this is a pretty big premium.
Whilst direct US exposure in portfolios is low, we have been able to benefit from US growth as we also have indirect exposure via some of our defined returns products which are linked to the S&P 500 as well as the FTSE 100. We feel this approach has a better risk/ reward profile at present than direct US equities.
Recent volatility in stockmarkets has presented us with opportunities.
markets are not down by over 40% we will get the return of our original investment.
We had planned to add to our defined returns holdings should the FTSE 100 drop to around 7,300. As we approached this level we were able to strike a new product with JP Morgan on 7 September when the FTSE closed at 7,318. Should the FTSE be at or above this level on 7 September 2019, the product will “kick out” and provide a 10.35% return. We think this is a attractive potential return given that it only requires the markets to go sideways over the period.
For more information on Defined Returns, please speak to your usual Equilibrium contact. Should markets remain volatile, we have further low risk assets on the sidelines which we would use to switch into equities on further dips in markets.
Should markets drop over 12 months, the product then rolls on to the second anniversary. If they are still below the starting level at that points it rolls onto the third anniversary and so on, up to a maximum of six years. At the end of the six years, providing the
Disclaimer: The content contained in this newsletter represents the opinions of Equilibrium Investment Management. The value of your investments will fall as well as rise. Any performance targets shown are what we believe are realistic long-term returns. They are never guaranteed. The commentary in this newsletter in no way constitutes a solicitation of investment advice. It should not be relied upon in making investment decisions and is intended solely for the entertainment of the reader.
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter September 2018
General Economic Overview The global economy continues to grow, but there are signs of tension affecting some emerging markets. The strong dollar and trade concerns have had an impact. In the US, it looks likely that interest rates will go up at least twice more in the next six months with a strong jobs market and growing economy. In the UK, recent falls in the pound may help keep inflation relatively high. However, we see it very unlikely rates will go up again any time soon given the ongoing uncertainty over Brexit.
Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Most markets look close to “fair value� in our view, after recent falls despite steady earnings growth. The exception is the US which looks very expensive. Whilst we expect decent long term returns, particularly from Asia, in the short term markets are likely to remain volatile.
-2
Fixed Interest Bond returns are likely to be positive but unspectacular in our view. We continue to prefer corporate to government bonds and hold a small amount of index linked as a hedge against a sterling driven inflation shock.
-3
Commercial Property Prospects for the asset class remain mixed. We still wish to avoid London offices and much of the retail sector. However, we are more optimistic about other cities and in the industrial sector. Our selective approach limits the amount we are able to invest in property at present.
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-3 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest, property and equity. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.
A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.
These represent EIM’s collective views. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser. Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.